Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Wednesday, September 26, 2012

CFTC Chair Gensler Tells European Parliament that LIBOR Should Rely on Observable Transactions

As UK FSA authorities preprare a plan to either reform or replace the LIBOR benchmark, CFTC Chair Gary Gensler told a committee of the European Parliament that benchmark rates should rely upon observable transactions. A rate that relies upon observable transactions is anchored by the reality of that price discovery, said Chairman Gensler, and has a well lit path to credibility. A rate that relies upon observable transactions is also less vulnerable to misconduct.

In remarks to the Economic and Monetary Affairs Committee, he also urged international regulators and market participants to work together collaboratively to improve LIBOR’s governance, manage the conflicts of interest and enhance the integrity of LIBOR reporting. Nevertheless, even if we address the issues of governance and conflicts of interest, we will still need to address the fundamental issue – that the underlying market for unsecured interbank borrowing has largely diminished. So much so that there may not be enough observable transactions in the unsecured interbank marketplace for people acting in good faith to accurately, estimate a rate for submission. If the market were to move to a replacement benchmark rather than just mending LIBOR, noted Chairman Gensler, it is crucial that the international process address an appropriate transition for people borrowing, lending or hedging based on LIBOR.

Broad market input would be necessary to establish protocols and market mechanisms for such a transition. Moreoverin his view, any such transition should ensure that homeowners, commercial enterprises, and others with contracts indexed to LIBOR have an ability to smoothly migrate in a way over time so as to be least affected by a possible change.

Since the attempted manipulation of the London Inter-Bank Offered Rate (Libor) has cast a shadow over the financial industry at large and the governance of the benchmark, the UK has begun a review of the benchmark with an eye towards reforming it or replacing it with an alternative benchmark. Retaining Libor in its current state is not a viable option given its identified weaknesses and the loss of credibility it has suffered. The review is under the direction of Martin Wheatley, Financial Services Authority Managing Director. Mr. Wheatley is also the Chief Executive-designate of the new Financial Conduct Authority.

Libor is a benchmark used to gauge the cost of unsecured borrowing in the London interbank market and sets the price for hundreds of trillions of dollars worth of derivatives and other financial contracts worldwide. In recent remarks, Mr. Wheatley noted that Libor is an integral part of the modern financial system, referenced in a huge number and variety of financial contracts. Although Libor is calculated in London, it is based on daily submissions from a number of international banks and is used as a global benchmark. A consultation was published August 10, 2012 under a very tight time frame. Director Wheatley will make recommendations very soon to the UK Government, which will then make a decision and implement any changes in the Financial Services Bill or the Banking Reform Bill.